Prepping parents for the FAFSA

As parents prepare their children to be responsible adults after high school, many create savings accounts in their childrens’ names. Sometimes those accounts can accumulate large sums of money over time or are used as a way to save for college. 

A child should learn to save money, and saving for college is a perfectly logical step. However, what most parents don’t understand is that significant savings in a child’s name is often actually a huge mistake when it comes to receiving financial aid. Counselors can play an important role in explaining that. 

If a family is absolutely certain they will not qualify for financial aid, there are some beneficial tax loopholes that can be utilized by putting money in a child’s name. Those can quickly be outweighed though if a family does qualify for aid. This is simply due to the fact that in the FAFSA formula, a parent’s assets will be assessed up to 5.65%. A child’s assets, however, will be assessed at 20%.

Let’s assume a family was lucky enough to have squirreled away $25,000 for their child’s college by the time the student graduated high school. 

• In the parent’s name
If that money was in a parent’s name, they would be expected to contribute 5.65% or $1,412.50 towards the first year of college. 

• In the child’s name
If that same $25,000 were in the child’s name, it would be expected they contribute 20% or $5,000 towards the first year. That difference could have been made up in grants, scholarships, or subsidized loans, if the money was in the parent’s name.

It should be said that when we are talking about assets here we might be talking about cash, bank accounts, CDs, savings bonds, stocks, mutual funds, trusts, even real estate. Any of these things, and other less traditional savings vehicles, that are listed in the child’s name will need to be listed as an asset of the child on the FAFSA. It is also worth noting that money in a 529 plan or state-sponsored pre-paid college plan are treated as parent assets even if the child is listed as a beneficiary. Therefore, either of those are probably better vehicles for saving for college than others though both tie the money to college expenditures. Steep penalties can be imposed if funds are withdrawn for expenditures that are not approved by the established guidelines of those plans.

If a parent already has money in a child’s name there are ways to move that around. However, that needs to be done prior to the year covered by the aid application. Moving money around can also place parents in a minefield of tax penalties that can quickly outweigh many of the benefits sought. In some cases, reallocation might not even be possible depending on the nature of the child’s account. Therefore it is never too early to discuss saving for college and high school counselors might consider setting up a financial aid table at events, like an open house at feeder schools. At the very least, it is a good idea to find opportunities to share financial aid information with counselors at feeder schools.